John Wiley & Sons, Inc. © 2005

Chapter 7Chapter 7

Internal Control and Cash

Prepared by Barbara MullerPrepared by Barbara MullerArizona State University WestArizona State University West

Principles of AccountingPrinciples of Accounting

Kimmel Kimmel •• Weygandt Weygandt •• Kieso Kieso

CHAPTER 7 INTERNAL CONTROL AND CASH

After studying this chapter, you should be able to:

Identify the principles of internal control.Explain the applications of internal control to

cash receipts.Explain the applications of internal control to

cash disbursements.Prepare a bank reconciliation.Explain the reporting of cash.Discuss the basic principles of cash

management.Identify the primary elements of a cash budget.

Internal control•Safeguards an organization’s assets

•Enhances the accuracy and reliability of accounting records

PRINCIPLES OF INTERNAL CONTROL

STUDY OBJECTIVE STUDY OBJECTIVE 11

PRINCIPLES OF INTERNAL CONTROL

ContinuedContinued

Establishment of responsibility: • most effective when only one person is responsible

for a given task

Segregation of duties: • the work of one employee should provide a

reliable basis for evaluating the work of another employee

Documentation procedures: • documents provide evidence that transactions and

events have occurred

PRINCIPLES OF INTERNAL CONTROL

ContinuedContinued

Physical, mechanical, and electronic controls• safeguarding of assets and enhancing accuracy

and reliability of the accounting records Independent internal verification:

• reviewing, comparing, and reconciling information from two sources

Other controls:• bonding of employees who handle cash, rotating

employee’s duties, and requiring employees to take vacations

PRINCIPLES OF INTERNAL CONTROL

ContinuedContinued

PHYSICAL, MECHANICAL, AND ELECTRONIC CONTROLS

COMPARISON OF SEGREGATION OF DUTIES PRINCIPLE WITH INDEPENDENT INTERNAL

VERIFICATION PRINCIPLE

Internal control is designed to provide reasonable assurance

• Costs of establishing control procedures should not exceed their expected benefits.

The human element is an important factor in every system of internal control.

• A good system can become ineffective through employee fatigue, carelessness, or indifference.

Collusion can occur.• Two or more individuals work together to get around

prescribed controls and may significantly impair the effectiveness of a system.

LIMITATIONS OF INTERNAL CONTROL

Cash • coins, currency, checks, money orders,

and money on hand or on deposit at a bank or similar depository

Internal control over cash is imperative• to safeguard cash and assure the

accuracy of the accounting records

CASH CONTROLS

INTERNAL CONTROL OVER CASH RECEIPTS

STUDY OBJECTIVE STUDY OBJECTIVE 22

INTERNAL CONTROL OVER CASH RECEIPTS

STUDY OBJECTIVE STUDY OBJECTIVE 22

INTERNAL CONTROL OVER CASH DISBURSEMENTS

STUDY OBJECTIVE STUDY OBJECTIVE 33

INTERNAL CONTROL OVER CASH DISBURSEMENTS

STUDY OBJECTIVE STUDY OBJECTIVE 33

Checks processing is expensive• new methods are being developed to transfer

funds among parties without the use of paper

Electronic Funds Transfer (EFT) System • a disbursement system that uses wire, telephone,

telegraph, or computer to transfer cash from one location to another

Cash Disbursements ELECTRONIC FUNDS TRANSFER SYSTEM

The use of a bank•minimizes the amount of currency that must be kept on hand•contributes significantly to good internal control over cash.

A “double” record of cash is maintained, one by the company, one by the bank. These two accounts are reconciled.

USE OF A BANK

BANK STATEMENTS

A bank statement shows:• checks paid and other debits charged against the account

• deposits and other credits made to the account

• account balance after each day’s transactions

The bank statement is a copy of the bank’s records sent to the customer for review

A bank statement shows:• checks paid and other debits charged against the account

• deposits and other credits made to the account

• account balance after each day’s transactions

The bank statement is a copy of the bank’s records sent to the customer for review

BANK STATEMENT

RECONCILING THE BANK ACCOUNT

STUDY OBJECTIVESTUDY OBJECTIVE 4 4

Reconciliation • is necessary as the balance per bank

and balance per books are seldom in agreement due to time lags and errors

A bank reconciliation• should be prepared by an employee

who has no other responsibilities pertaining to cash

Steps in preparing a bank reconciliation:• Determine deposits in transit

• Determine outstanding checks• Note any errors discovered• Trace bank memoranda to the records

Each reconciling item used in determining the “Adjusted cash balance per books” should be recorded by the depositor

RECONCILING THE BANK ACCOUNT

BANK RECONCILIATION

BANK RECONCILIATION

W. A. LAIRD COMPANY

Bank Reconciliation

April 30, 2005

Cash balance per bank statement $ 15,907.45 Add: Deposits in transit 2,201.40 18,108.85 Less: Outstanding checks No. 453 $ 3,000.00 No. 457 1,401.30 No. 460 1,502.70 5,904.00

Cash balance per books $ 11,589.45 Add: Collection of $1,000 note receivable plus interest earned $50, less collection fee $15 $ 1,035.00 Error in recording check 443 36.00 1,071.00 12,660.45 Less: NSF check 425.60 Bank service charge 30.00 455.60

Adjusted cash balance per bank $ 12,204.85

Adjusted cash balance per books $ 12,204.85

The bank statement for the Laird Company shows a balance per bank of $15,907.45 on April 30, 2005.

The bank statement for the Laird Company shows a balance per bank of $15,907.45 on April 30, 2005.

On this date the balance of cash per books is $11,589.45.

On this date the balance of cash per books is $11,589.45.

ENTRIES FROM BANK RECONCILIATION

Collection of Note Receivable This entry involves four accounts. Interest of $50 has not been accrued and the collection fee is charged to Miscellaneous Expense.

Collection of Note Receivable This entry involves four accounts. Interest of $50 has not been accrued and the collection fee is charged to Miscellaneous Expense.

1035 15 1000 50

ENTRIES FROM BANK RECONCILIATION

Book Error An examination of the cash disbursements journal shows that check No. 443 was a payment on account to Andrea Company, a supplier. The check, with a correct amount of $1,226.00, was recorded at $1,262.00.

Book Error An examination of the cash disbursements journal shows that check No. 443 was a payment on account to Andrea Company, a supplier. The check, with a correct amount of $1,226.00, was recorded at $1,262.00.

3636

ENTRIES FROM BANK RECONCILIATION

NSF Check An NSF check becomes an accounts receivable to the depositor.NSF Check An NSF check becomes an accounts receivable to the depositor.

425.60 425.60

ENTRIES FROM BANK RECONCILIATION

Bank Service Charges Check printing charges (DM) and other bank service charges (SC) are debited to Miscellaneous Expense because they are usually nominal in amount.

Bank Service Charges Check printing charges (DM) and other bank service charges (SC) are debited to Miscellaneous Expense because they are usually nominal in amount.

30 30

REPORTING CASHSTUDY OBJECTIVESTUDY OBJECTIVE 5 5

Cash • Recorded in both the balance sheet and the

statement of cash flows

• The balance sheet shows the amount of cash available at a given point in time

• The statement of cash flows shows the sources and uses of cash during a period of time.

REPORTING CASHCash Equivalents

Cash equivalents are • Readily convertible to known amounts of

cash• So near maturity that their value is

relatively insensitive to interest rate changes

• Examples include treasury bills, commercial paper, and money market funds

REPORTING CASHRestricted Cash

Restricted cash is • Restricted for a special purpose and not

available for general use

• Reported separately on the balance sheet

MANAGING AND MONITORING CASH

The objective of managing cash is to• Ensure that the company has sufficient cash

to meet payments, yet

• Minimize the amount of idle cash on hand

The operating cycle of a merchandising company is the average time it takes to go from cash to cash in producing revenues

Operating Cycle of a Merchandising

Company

Operating Cycle of a Merchandising

Company

Basic Principles of Cash Management

STUDY OBJECTIVESTUDY OBJECTIVE 6 6

Basic Principles of Cash Management

STUDY OBJECTIVESTUDY OBJECTIVE 6 6

Cash is vitalThe cash budget includes a cash receipts, cash disbursements, and financing section•It shows the anticipated cash flows, over a 1 to 2-year period

CASH BUDGETINGSTUDY OBJECTIVE STUDY OBJECTIVE 77

CASH BUDGETING

Cash receipts section includes expected receipts from the company’s principal sources of revenue

Cash disbursements section includes expected payments for direct materials, direct labor, etc.

Financing section shows expected borrowings and their repayment

Let’s ReviewLet’s Review

Which one of the following is not one Which one of the following is not one of the sections of a cash budget?of the sections of a cash budget?

a.a. cash receipts section.cash receipts section.

d.d. cash from operations section.cash from operations section.

c.c. financing section.

b.b. cash disbursements section.cash disbursements section.

Let’s ReviewLet’s Review

Which one of the following is not one Which one of the following is not one of the sections of a cash budget?of the sections of a cash budget?

a.a. cash receipts section.cash receipts section.

d.d. cash from operations section.cash from operations section.

c.c. financing section.

b.b. cash disbursements section.cash disbursements section.

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Copyright © 2005 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written consent of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.

Copyright © 2005 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written consent of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.